Massive buyback drives recovery in Scottish Mortgage share price

Over the 12 months ended 31 March 2024, Scottish Mortgage returned 11.5% in NAV terms and 32.5% in share price terms, driven by a narrowing discount. It says that these figures compare to a 21.0% return on the FTSE All-World Index.

The main driver of the narrowing discount from 19.6% to 4.5% was the announcement of the company’s £1bn share buyback, which was announced in the face of stakebuilding by activist investor Elliott Associates. The statement says that the board and managers are committed to facilitating trading around net asset value in normal market conditions. 68.5m shares were bought back over the period from 1 April 2023 to 22 May 2024, at a total cost of £592m, which represented 4.9% of the share capital in issue at the start of the year.

The total dividend for the year is being increased by 3.4% to 4.24p, marking 41 years of consecutive dividend increases.

Extracts from the manager’s report

Last year’s largest holding (and biggest headwind [to returns]) [was] Moderna. Vaccine fatigue has presented a challenge for the company, with vaccination levels for endemic Covid-19 well below expectations. There are several possible explanations for this, but the virus remains more lethal than influenza and vaccination rates are less than half. Moderna is resilient in the face of these events. The windfall it received from its Covid-19 vaccine has given it a substantial cash position to fund the deployment of its technology into other areas.

Our reasons for having a significant investment in the company remain unchanged. In the near term, the company’s respiratory vaccine franchise will grow. It has seen promising results from its trials of RNA-based vaccines for flu and RSV and ought to be able to combine these vaccines with Covid-19 into a single shot, which will be better for patients and cheaper for the healthcare system. As its work on other respiratory viruses comes to fruition, it should be able to add these and update for prevalent strains to ensure maximum efficacy. Reducing hospital bed occupancy in the winter flu season will be highly beneficial. The work the company is doing on several other viruses, such as EBV and CMV, will help prevent these infections and, importantly, address the impact that they can have on health later in life. The data from trials of a personalised cancer vaccine that enables the body’s immune system to identify cancerous cells and remove them continue to be very encouraging.

Our largest holdings, NVIDIA and ASML, are in the semiconductor industry. Demand for NVIDIA’s chips has vastly exceeded expectations, which has been an important driver of our returns. Without NVIDIA’s silicon or software, we would not be seeing such remarkable progress from AI systems. Our key consideration is the duration of the edge it has built over the competition. ASML, the Dutch manufacturer of the lithography equipment needed to produce cutting-edge semiconductors, has one of the most apparent competitive advantages we’ve ever encountered. Its innovations are the central enablers of miniaturisation in semiconductors. Growth in datacentres and AI applications augment the growing demand for chips in many industries. At the same time, chips are getting bigger, and the desire for greater sovereignty in semiconductors is fuelling demand for capital equipment. The offset to these encouraging trends is geopolitics impinging on the company’s equipment sales in China. The immediate challenge is demonstrating that innovation can continue following the retirement of CEO Peter Wennink and President and CTO Martin van den Brink.

Amazon and Spotify have taken drastic action to increase their resilience in the past year, and stock markets have strongly rewarded them both. We added to Amazon, and it has regained its position as one of our top holdings. It is now reaping the benefits of substantial capacity increases made during Covid-19. Periods of investment and cost increases at both companies have ended, and there has been a much greater focus on efficiency, reflected in margin improvement. The growth opportunities are exciting, and both exemplify the types of businesses that seem likely to benefit from developments in AI. We are seeing many companies invest in AI systems to improve their operations but for investors, there is an essential question of whether this generates additional returns or ends up being a zero-sum game. Spotify is a platform business that benefits from the breadth and scale of content on its platform. AI will likely lead to an explosion in available content, improving its economics in a way that others cannot mitigate. If AI revolutionises how we purchase products, this is likely to favour Amazon, the company with the most consumer data and a vast physical infrastructure for getting products to those consumers.

Tesla, which we reduced partway through the year, is at a fascinating juncture. Its recent products have been hugely successful, and preliminary sales data indicate that the Model Y was the best-selling vehicle in the world last year. However, the rise in interest rates has reduced the affordability of all high-ticket items, including Tesla vehicles, depressing demand. At the same time, the rapid scaling of Chinese electric vehicle production, along with improving quality, is a powerful source of competition and pricing pressure. All of this may be irrelevant to the long-term investment story. Tesla’s massive investment in AI looks to be paying off with the rapid improvement in its self-driving software. User reports on the latest version, now entirely AI-controlled, are very favourable, and the company is installing it in all new US vehicles. [though my social media keeps showing a video of a Tesla trying to drive into a moving train – maybe that’s the old version] Tesla is harnessing the same investments to produce humanoid robots, whose capabilities are progressing along an exponential trajectory.

Our largest private position, SpaceX, now a bigger holding than Tesla, launched 96 rockets last year (accounting for two-thirds of all commercial launches). It has no peers when it comes to scale and cost efficiency. The company’s latest rocket, Starship, has unprecedented capabilities and will transport 150 metric tonnes of payload. It is close to commercial launch. Starlink, the satellite communications subsidiary, has 2.3 million subscribers and is growing rapidly bringing connectivity to underserved parts of the world. Its unique access to launch capacity puts it way ahead of potential competitors. It already has sufficient scale to generate cash.

There has been little change elsewhere in our private portfolio. Our top ten private holdings represent approximately two thirds of our private exposure, and the operating performance of these companies has been encouraging. We selectively supported holdings that raised money in the year. With financial markets activity subdued, very few companies moved from private to public markets.

The combination of a weak domestic economy, an uncertain regulatory environment and geopolitical concerns have made the inclusion criteria for Chinese stocks in the portfolio more demanding. However, the vast domestic market and exceptional entrepreneurs mean we continue to take Chinese investments seriously. Ecommerce giant Pinduoduo has a proven track record of building a discount retail offering in China and turning it into a profitable business. It is now attempting the same thing overseas, and the pace of rollout for its platform, Temu, has been very impressive. The international pattern of profitability is tracking what we have seen previously in China. We added to Meituan, the local services company, which has proven leadership and the scope for meaningful profit growth in the years to come.

We have sold our position in Tencent*, the Chinese mobile platform, which has been a prominent holding for us over the past fifteen years. We have massive respect for the team there, who have proven to be phenomenal operators and astute investors. We think that ongoing political and regulatory developments mean that the constraints that go with scale for Chinese businesses have increased substantially. As a result, it will be difficult for Tencent to meet our more demanding inclusion criteria over the coming years.

We also sold another long-standing holding, Illumina. We believe that genomic sequencing is a fundamental building block for improving healthcare in the coming decades. However, the company’s execution could have been better, and the work required to drive demand and lower costs will be challenging for some time. Several other holdings are utilising genomic sequencing to improve health outcomes. The progress made by Tempus in using sequencing data to guide the treatment of US cancer patients is impressive, and potential applications of the approach continue to multiply.

SMT : Massive buyback drives recovery in Scottish Mortgage share price